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Friday, January 16, 2009

Mike Larson at MoneyandMarkets has something interesting to say about the FHLB system, as if we didn’t have enough to worry about! His remarks make clear what’s happening in short order:

Federal Home Loan Banks following Fannie,Freddie, private banks over a cliff?

Unless you follow the banking industry closely, you probably haven't heard of the Federal Home Loan Banks. But the FHLBs are vitally important as a source of funding for U.S. banks both large and small. There are 12 of them spread around the country — in Atlanta, Boston, Chicago, Cincinnati, Dallas, Des Moines, Indianapolis, New York, Pittsburgh, San Francisco, Seattle, and Topeka.FHLBs sell debt into the capital markets to raise money, using their AAA ratings to borrow cheaply. They use that money to make advances to banks that are members of the system and take collateral in exchange — often mortgages or mortgage-backed securities.

The banks use the money they get from the FHLB, along with cash raised elsewhere from their own debt sales and depositors, to make loans. The banks are required to own stock in the FHLBs, and that stock helps capitalize the regional FHLBs.So what's the problem?

The FHLBs own billions and billions of dollars worth of mortgage backed securities. Those securities have plunged in value. So just like their banking customers, FHLBs are facing potentially huge write-downs on their portfolios. They may also be losing money on derivatives they employ.

And that's what is stressing the system.Specifically

The Seattle FHLB just warned that it may miss one of its capital targets. It may be barred from paying dividends on the stock member banks hold in it, potentially impacting those institutions counting on the money.

The San Francisco FHLB also said earlier this month that it was facing impairment charges, and that it wouldn't pay a fourth-quarter dividend as a result.

Moody's recently warned that eight out of the 12 FHLBs could ultimately face capital problems thanks to losses on their $76 billion of mortgage securities not backed by Fannie Mae and Freddie Mac.

Now here's where it gets really interesting: While many investors have never heard of the FHLBs, they collectively have roughly $1.25 trillion — with a "T" — in debt outstanding. That makes them the biggest borrowers in the U.S.— behind the federal government!

If you thought it was expensive to bail out Fannie Mae and Freddie Mac (The Treasury has pledged to inject up to $200 billion in capital into the two of them), just you wait. Should the FHLBs need a bailout, there's no telling how much it will cost!In other words, we're looking into the maw of yet another gigantic black hole!